GAO Finds Fault with Forced Transfers of 401(k)s to IRAs

When an employee has saved less than $5,000 in a 401(k) plan and changes jobs without indicating what should be done with the money, the plan sponsor can transfer the account savings into an individual retirement account (IRA) in a “forced transfer” under Department of Labor (DOL) regulations.

Most forced-transfer IRA balances will decrease substantially if not reinvested, because the fees charged to the IRAs often outpace the low returns earned by the conservative investments prescribed by the DOL's safe harbor regulations, the GAO found.

In recent years, the typical forced-transfer IRA investment (a money market account) has earned almost no return. Over the decade ending July 31, 2014, taxable money market funds averaged an annual return of just 1.45 percent.

“A low return coupled with administrative fees, ranging from $0 to $100 or more to open the account and $0 to $115 annually, can steadily decrease a comparatively small stagnant balance,” the GAO report said. “Using the forced-transfer IRA fee and investment return combinations, we projected the effects on a $1,000 balance over time. While projections for different fees and returns show balances decreasing at different rates, generally the dynamic was the same: small accounts with low returns and annual fees decline in value, often rapidly. In particular, we found that 13 of the 19 balances [studied by the GAO] decreased to $0 within 30 years.”

The fees and investment returns of one provider that the GAO studied would reduce an unclaimed $1,000 balance to $0 in just nine years. “Even if an account holder claimed their forced-transfer IRA after a few years the balance would have significantly decreased,” the report noted.

Looked at another way, the GAO’s analysis showed an average decrease in a $1,000 account balance of about 25 percent over just five years. Given the median fees for the forced-transfer IRAs the GAO reviewed, “the investment return on $1,000 would have to be more than 7.3 percent to keep pace with both the rate of inflation and the fees charged.”

Low-Yielding Investments

In contrast, the default investments used by many 401(k) automatic enrollment plans produce a better long-term return than the conservative default investments for forced-transfer IRAs, the GAO said. The most popular default investments for auto enrollment in 401(k) plans are target date funds that hold a mix of stocks, bonds and other investments. In recent years, assets in target date fund default investments have produced a higher return than typical forced-transfer IRA money market investments, which, as noted, have seen minimal returns.

As an example, the GAO reported that under reasonable return assumptions, if a former employee’s $1,000 forced-transfer IRA balance was invested in a target date fund, the balance could grow to about $2,700 over 30 years, while the balance would decline to $0 if invested in a money market account, given that the likely IRA fees would be greater than expected returns.

Source: GAO

Consolidated Accounts Unprotected

The GAO also found that a provision in the law governing forced transfers allows a 401(k) plan sponsor to disregard previous rollovers when determining if a balance is small enough to force out. For example, a plan sponsor can force out a participant with a balance of $20,000 if less than $5,000 is attributable to contributions made while at the employer, excluding rollover contributions from a previous employer’s 401(k) plan.

“Participants trying to consolidate their savings as they move from job to job could ultimately lose their ability to remain in a 401(k) plan with its choice of investments and could realize a lower retirement savings balance because of the current provision allowing rollover balances to be forcibly transferred out of the plan,” the GAO warned. “Absent a change in law, active plans can continue to force out participants who have account balances over $5,000 by excluding rollover funds when calculating the vested balance, creating a disadvantage for those workers who change jobs and consolidate to keep their retirement savings [in one 401(k) plan].”

Overburdened Participants

“Some 401(k) plan participants find it difficult to keep track of their savings, particularly when they change jobs, because of challenges with consolidation, communication and information,” the GAO cautioned.

For instance, maintaining communication with a former employer's plan can be challenging if companies are restructured and plans are terminated or merged and renamed, the report pointed out. Key information on lost accounts may be held by different plans, service providers or government agencies, and participants may not know where to turn for assistance.

“Although the Social Security Administration provides individuals with information on benefits they may have from former employers' plans, the information is not provided in a consolidated or timely manner that would be useful to recipients,” the GAO noted.

Recommendations

To address these issues, the GAO recommended that Congress and executive branch agencies consider several actions. For instance, executive agencies should take steps to:

Ensure that 401(k) plan participants have timely and adequate information to keep track of all their workplace retirement accounts. The Social Security Administration should make information on potential vested plan benefits more accessible to individuals before retirement by consolidating information on potential vested benefits (currently sent in the Potential Private Retirement Benefit Information notice) with the information provided in the Social Security earnings and benefits statement.

Prevent forced-transfer IRA balances from decreasing due to low returns in the investment options currently permitted by the DOL’s safe harbor regulation. The DOL should revise the forced-transfer IRA safe harbor regulations to include investment options currently available under the qualified default investment alternatives regulation that apply to automatic enrollment in 401(k)s, including target date funds, and permit forced-transfer IRA providers to change the investments for IRAs already established.

Ensure that individuals have access to consolidated online information about their multiple 401(k) plan accounts. The DOL should convene a task force to consider establishing a national pension registry. The task force could include industry professionals, plan sponsor representatives, consumer representatives and relevant federal government stakeholders, such as representatives from the Social Security Administration, the Pension Benefit Guaranty Corp. and the Internal Revenue Service, who could identify areas to be addressed through the regulatory process as well as those that may require legislative action.

The GAO advised Congress to consider amending current law to:

Permit the DOL and Treasury Department to identify and designate alternative default destinations for forced transfers greater than $1,000, should they deem them more advantageous for participants.

Repeal the provision that allows plans to disregard amounts attributable to rollovers when determining if a participant's plan balance is small enough to forcibly transfer it.

“The problems identified by the GAO are relatively small, well defined and fixable,” commented Alicia H. Munnell, director of the Center for Retirement Research at Boston College,
in a commentary posted at MarketWatch. “We should be able to overcome the challenges associated with inactive account balances.”